Subscribe to my newsletter, FREE!
MARK RUHINDI
Uganda is seeing a resurgence of growth in the real estate sector following the full opening of the economy in 2022 after almost 2 years of slow growth which resulted from the covid 19 pandemic lockdowns that affected every sector of the economy, construction and real estate inclusive.
We have also seen a new rental tax and landlord-tenant relations regulatory regime ushered in by both the Income tax (amendment)Act 2022 and the Landlord and Tenant Act 2022 respectively.
In this opinion, I’ll attempt to highlight the salient features of the entire taxation regime of the real estate sector under the tax heads of withholding tax, Income tax, rental tax, VAT and Stamp duty. I have tried to simplify and water down legalese such that the text is comprehensible for lay people but equally helpful for technical people alike. Landlords, property dealers, tax consultants, tax administrators, policy makers as well as students of revenue law and taxation will find the blog post helpful.
Levies under the Income Tax Act
The Income tax Act levies income tax and rental tax against real estate businesses separately as two distinct subcategories. And so whereas most players in the market are under the impression that once they have filed a rental tax return and accounted for rental tax to URA, their liabilities are fully settled, but this is erroneous; Tax payers in the real estate industry are also under the obligation to file income tax returns and in certain cases may also be under the obligation to account for withholding tax.
Rental tax
The Act defines rental income, in relation to a person for a year of income, as “the total amount of rent derived by the person for the year of income from the lease of immovable property in Uganda, with the deduction of any expenditures and losses incurred in respect of the property”. And Rent is defined as “Any payment including a premium or any like amount, made as consideration for use or occupation of, or the right to use or occupy, land or buildings”
It follows therefore that rental tax is strictly levied against this income known as rental income. There is another category of income which might come into the hands of a real estate player known as business income, in real estate most of this income arises from capital gains as a result of the appreciation in value of real estate assets. And so upon lease or sale of real estate assets, the profit made is taxable under this head.
Below are the full list of subcategories under which business income might arise.
Business income is defined by the Act to include all income earned by a person carrying on a business, whether of a revenue or capital nature; The act lists some 7 subcategories of business income, which include;
- Gains or losses on disposal of assets,
- Cancellation of business debts;
- Consideration for accepting a restriction on a person’s capacity to carry on business;
- Proceeds from the disposal of trading stock;
- Value of gifts derived in the course of, or by virtue of, a past, present or prospective business relationship
- Interest derived on trade receivables and,
- Recouped expenditure, e.g a Bad debt that is later recovered.
Important to note is that owners of real estate businesses can and are liable to pay tax on income falling under all the 7 categories.
However for purposes of this article I will restrict myself to discussing the obvious categories to avoid confusing the less sophisticated section of my readership, these are;
- Capital gains on disposal of real estate assets which are “business assets” and are therefore of a capital nature, AND
- Profit arising from the normal course of trading in real estate property which are trading stock and are therefore of a revenue nature.
In the first case, the investor might not be a trader in real estate assets but merely one who happens to hold real estate assets as part of their long term/capital asset portfolio. An example is a factory warehouse or office building upon which a manufacturer operates. Income arising upon sale of the office or warehouse building is taxed under this head.
In the second case, the investor has a “shop” and their stock in trade are real estate properties which are on sale just like with any other shop selling any random trade items you can think of and for a real estate dealer this includes the property upon which the real estate dealer carries on their trade and has a locus in quo, or simply put their operations location.
NOTE; The Income tax Act does not expressly make this pronunciation but we have guidance from case law. In the English case, Golden Shoe Horse (New) Ltd v Thurgood [1933] 18TC280, the court held that all land on which a real estate dealer carries on his business is part of his circulating capital or part of his stock in trade and its cost must be debited in the profit and loss account.
The Ugandan Tax Appeals Tribunal recently has upheld this distinction in MAKERERE UNIVERSITY RETIREMENTS BENEFITS SCHEME LTD v URA and ANOTHER, TAT Application 17 of 2021, wherein the Hon.Chairman and members observed; “If the tribunal was to hold that ‘business assets’ includes all items used in the ordinary course of business because they are ‘sold’ or ready for sale, and are to attract withholding tax, it would mean that the definition of ‘business assets’ extends to stock in trade”. and then held; Business assets and stock in trade comprises assets in a business, however it is only business assets and not stock in trade that attracts withholding tax.
These observations present a tax planning opportunity for tax payers in the real estate sector which I will be happy to discuss at an opportune time whenever called upon.
Distinction must also be made between;
1, An individual real estate owner who invests in real estate for returns on investment through rental income revenue in a one off transaction AND,
2. A real estate company or individual trader/flipper or one who invests in real estate for resale for a profit upon resale. They may also earn rental income. An obvious example is the many residential condominium developers now in Uganda who are building condominium homes for sale.
In the first case, the real estate owner is clearly not a trader and so they are taxed only under the rental tax head, but may also be liable to withhold tax as agents if they are purchasing the real estate asset which is a business asset. Such a purchaser is at law obligated to withhold 10% of the consideration price if the vendor is a non resident and 6% if the vendor is a resident and account for the tax to URA through a withholding tax return.
All resident real estate companies are expected to file a return and account for capital gains tax/business income at a rate 30% of changeable income, rental tax at a rate of 30% of chargeable income(if they earn any rental income) and withholding tax(as agents) if they purchase a real estate asset from a non-resident(10%). In the case of individuals, the taxman can only levy tax if their activities indeed constitute real estate trade and are not one off transactions, save for the withholding tax above. The tax rate for individuals’ real estate trade activities is the same rate as that provided under PAYE.
The above is why URA has found it imperative to set a mandatory requirement for everyone buying or selling real estate assets to have a TIN and to offer a record of every transaction before transfer can be effected. Because everyone is potentially a withholding agent for capital gains tax on the purchase of real estate business assets from non residents and if their activities constitute trade then they are accountable to URA for income tax from business income earned out of these trade activities. The purpose of the new rules is to enable URA to identify real estate traders/businesses.
In tax law the question of ‘what is a business’ or rather ‘who is trading’ is a question of both fact and law and the test/criteria for determination of this question is by looking at scale/volume of operations, commercial or profit motive, repetition or continuity of activities, and whether a business vehicle is employed. In the absence of evidence to the contrary, the natural presumption at law is that any incorporated entity or organised business association is a trader and so this test applies to individuals and less often to non-individuals. Also to note is that the absence of one in the criteria highlighted does not negate the existence of taxable trading activities.
And so using the above articulated test/criteria and the transaction data gathered over time, URA will be able to identify who is a real estate trader/business, i.e, those involved in the purchase and sale of real estate properties as repetitive/continuing trade/business activities as opposed to one off transactions such as buying a family home.
It is this transaction data gathered by URA over the course of time, which will enable it to conduct audits and raise income tax, withholding tax and VAT assessments on trade activities that may go back 5 years or so, and seek to recover tax that may not have been accounted for and declared by these real estate dealers/businesses. It is therefore advisable for this category of real estate industry players to undertake income tax compliance steps without delay. This is to avoid scenarios where a real estate company or an individual engaged in real estate business is handed assessments that may include interest and penal tax, which can easily raise an entity’s overall balance sheet liabilities beyond unmanageable limits and bring down the business.
Taxation of serviced apartments.
Kampala has seen a rise in the hotel like business model, where owners of apartments furnish them and operate them under a hybrid model akin to a hotel business model for both short and long term stays. A real estate business owner of such properties shouldn’t fall under the mistaken impression that they’re not liable to comply under the rental tax regime.
Taxation of earnings from these properties falls under both income tax and rental tax unless they are approved hotels as provided under the Act and the approved industrial buildings regulations. It follows therefore that all owners of furnished apartments who operate them as such are liable to file returns and account for rental tax arising from these properties, as well as income tax unless they have been designated as hotels and approved as such, in which case they would only be taxed under the income tax head.
Revenue/Expense deductions.
Pursuant to the Income Tax (amendment)Act 2022, we once again have a different rental income compliance criteria for individuals and companies away from the uniformity that had been ushered in by the 2021 income tax amendment which was repealed after only one fiscal year. The rental tax rate for individual taxpayers currently stands at 12 % of chargeable rental income while that of companies is 30% of chargeable rental income and there are no deductions/expenses allowed for taxpayers who are individuals at all.
Companies are entitled to deduct all expenses allowed under the Act but up to the cap of 50% of gross rental income. And where allowed deductions for the year of income exceed 50% of rental income revenue, then the taxpayer is only entitled a singular one off deduction of 50% of rental income revenue and nothing more.
And so chargeable income for individuals is now gross rental collections less the minimum threshold of 2,820,000/- while chargeable income for companies is now gross rental collections minus deductions allowed under the Act but which must not exceed 50% of gross rental collections.
The deduction for interest paid on mortgage amounts from a financial institution spent in building or acquiring premises that generate rental income was repealed and is no longer available to both individuals and companies alike.
However the same is still available for compliance under capital gains/business income and so real estate businesses and traders who comply under this head still have interest deduction for loans which are structured as revenue loans.
The implication of this is that borrowers and bankers (AND THIS IS VERY IMPORTANT) must now be careful when structuring loan transactions. This is because the moment a loan is structured as a building or mortgage loan, then that makes the loan a capital loan (a loan that adds to the capital structure of the business as opposed to the revenue structure), this would mean the borrower may lose the interest deduction under the Act even for compliance under business income. Since the deduction under rental tax compliance which would have been a refuge provision for the taxpayer was taken away. I must note however that this observation is born out of my own appreciation of a general principle of taxation relating to this aspect of tax law and which has yet to be tested in our courts in any tax dispute.
Capital allowances
For a real estate business to benefit from capital allowances under the law, the real assets to which the claimed allowances relate must be approved buildings. Approved industrial buildings are; approved/licensed hotels, approved hospitals and approved commercial buildings which include commercial or office buildings and warehousing and storage facilities but do not include residential property.
The capital allowances regime allows the trader to depreciate their capital outlay on industrial buildings over the life of the industrial buildings. And so a taxpayer who places a new industrial building in service for the first time is allowed an annual depreciation allowance of the cost base spread across the life of the building.
VAT
Subject to the Value added Tax Act, a taxable person who makes a taxable supply of immovable property is under the obligation to withhold VAT at a rate of 18% of the transaction value and remit the same to URA in a return filed by the 15th of the month following the month in which the transaction was made. A taxable person is one whose total supplies within a period of 3 calendar months is UGX 37,500,000/- and above, WHETHER OR NOT THEY HAVE APPLIED FOR VAT REGISTRATION.
NOTE; Certain supplies are VAT exempt and so tax advice ought to be taken at transaction stage to ascertain one’s obligations taking into account the facts of the transaction as a whole.
It follows therefore that every time a real estate business makes a taxable transaction or transactions whose value is equal to or above this threshold within a three month window, they’re liable to withhold and declare VAT on such transaction or transactions. Failure to do so may lead to retrospective registration of such a trader and an assessment to the tax together with interest and other associated penal tax sanctions.
Stamp duty
Pursuant to the Stamp Duty Act, a transfer instrument vesting a legal estate in a real estate asset from one party to another is chargeable with stamp duty which should be paid within forty five days of execution of the instrument. The duty rate is 1.5% of the transaction value and is payable to URA upon verification of the value of the property by the government valuer. The government valuer might attach a higher value to the transaction, above the consideration price paid by the purchaser to reflect the true value of the property for stamp duty assessment purposes if what is declared in the transfer instrument or sale agreement is abnormally low.
Conclusion
The above discussion is by no means comprehensive but merely a simple breakdown watered down for a lay person’s understanding of how withholding tax, Income tax, VAT and Stamp duty tax liabilities might arise from a single real estate transaction or an industry player’s trade activities over the course of time. Depending on the commercial nature and subject of the transaction or business and on the facts generally, some of the transactions might be tax exempt under some or even all of the above tax heads and so legal/tax transaction advice which takes into account both tax planning and compliance will be needed by a party to a real estate transaction in order to avoid pitfalls like tax overpayment and to mitigate compliance risk which easily compounds liabilities.
Real estate transactions of UGX 37,500,000/- AND ABOVE carry a VAT component to them, and so with URA’s current aggressive stand, taxpayer’s may need to treat large real estate transactions as complex commercial transactions for which a lay ordinary trader or party may need not just legal but ought to take transaction tax advice too.
The tax advice might take into account the commercial nature of the entity or parties to transactions, the subject matter, volume of a trader’s activities, tax residence status of the parties, exemptions under the different statutes and it is the tax treatment of these variables which will inform the deal structure of a transaction or the corporate structure through which a trader chooses to do business from a tax planning perspective and for proper compliance under the articulated taxing statutes and tax heads. Going forward therefore, it is recommended and best for real estate dealers henceforth to always take transaction advice that takes into account the articulated tax aspects of the transaction and perhaps equally importantly to periodically take tax health check advice in regards to their trading entities/trade activities.
Subscribe to my newsletter, FREE!
Discover more from MRT Tax
Subscribe to get the latest posts sent to your email.